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A monitor displays stock info on the floor of the New York Stock Exchange on July 11, 2016.Eric Thayer/Bloomberg

Maybe the surging stock market knows something we don't know, or perhaps investors are blithely ignoring anything that might crash their little party.

Either way, the market's ebullience seems at odds with the bleak outlook for second-quarter earnings season, which kicks into high gear this week and could well determine whether the rally continues or runs out of steam.

According to FactSet Research, earnings for S&P 500 companies are expected to tumble 5.5 per cent from a year earlier. It would mark the fifth consecutive quarter of year-over-year declines, something we haven't witnessed since the period ending in the third quarter of 2009.

Despite the ongoing softness in earnings, stocks have been soaring. Since Feb. 1, the S&P 500 has posted a total return of nearly 13 per cent, while Canada's S&P/TSX composite index has returned about 16 per cent (both figures include dividends).

Given the divergence in earnings and stock prices, it's perhaps not surprising that market valuations have risen to levels that are raising caution flags for some investors.

The S&P 500 has recently been hitting record highs and, as of late last week, traded at a price-to-earnings multiple of 19.4. "This marked the highest trailing 12-month P/E ratio for the S&P 500 since February 12, 2010," FactSet said. It's also well above the S&P 500's five- and 10-year average P/Es of less than 16.

The fact that interest-rate hikes are off the table is one factor in the market's advance. It's also possible that investors are already writing off the second-quarter results and looking ahead to an eventual rebound in earnings. According to FactSet, analysts expect earnings to finally turn positive in the third quarter.

Netflix in focus

A high P/E – even an egregiously high P/E – doesn't necessarily signal a stock's imminent collapse. For proof, look no further than Netflix Inc., which reports second-quarter results after the close on Monday.

Shares of the video-streaming service have been defying gravity for years and now trade at a multiple of 360 times estimated earnings for the current year.

Netflix's earnings will have to grow by leaps and bounds to justify such a high P/E, but don't expect any sign of that in Monday's earnings release.

"We continue to believe that Netflix is overvalued," long-time Netflix bear Michael Pachter of Wedbush Securities said in a note to clients. With content costs soaring, subscriber growth slowing and Amazon's video service having "declared war" on Netflix, "we expect Netflix to continue to bleed cash for the foreseeable future," he said.

"We have modelled cash burn of $1.38-billion (U.S.) in 2016, up from last year's $920-million, and we do not expect the company to generate positive [free cash flow] this decade," he said.

Mr. Pachter expects Netflix to report earnings of just 3 cents a share in the second quarter – a penny above the Wall Street consensus of 2 cents and down from 6 cents a year earlier.

For now, Netflix investors are more concerned with subscriber growth, which – so the theory goes – will eventually translate into profit growth. If subscriber numbers disappoint, watch out.

Big names on deck

A total 140 S&P 500 index members will report this week. Major companies include Bank of America Corp., International Business Machines Corp. and Yahoo Inc. on Monday, Johnson & Johnson, Goldman Sachs Group Inc. and Microsoft Corp. on Tuesday, American Express Co., Intel Corp. and Mattel Inc. on Wednesday, General Motors Co., Starbucks Corp. and Visa Inc. on Thursday and General Electric Co. on Friday.

Among Canadian companies, Canadian Pacific Railway Ltd. reports on Wednesday, followed by Encana Corp. and Rogers Communications Inc. on Thursday. Investors will be looking to see if Rogers can continue to grow the number of postpaid wireless and Internet subscribers, both of which rose in the first quarter even as Rogers's earnings missed estimates. Rogers's shares have risen recently, which may signal that investors are expecting solid second-quarter results.

Inflation, retail sales expected to soften

It's a light week for economic data, but Friday features two key Canadian reports – retail sales for May and the consumer price index for June.

"Retail sales have been a bright spot in the Canadian outlook, although a slip-up in auto sales in May should stall the consumers' progress," Canadian Imperial Bank of Commerce economist Nick Exarhos said in a note. He expects headline retail sales to drop by 0.3 per cent.

CIBC sees the headline CPI rising just 1.3 per cent year-over-year in June – lower than the consensus estimate of 1.7 per cent.

"Gasoline prices were up modestly on the month, but given that we are lapping a firmer runup in prices from last year, their impact on the overall year-on-year rate will push it lower. Furthermore, anecdotal evidence suggests that food prices continued to slip in June," Mr. Exarhos said.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 11:34am EDT.

SymbolName% changeLast
AXP-N
American Express Company
-0.36%226.92
BAC-N
Bank of America Corp
-0.26%37.71
CM-N
Canadian Imperial Bank of Commerce
+1.12%50.63
CM-T
Canadian Imperial Bank of Commerce
+1.03%68.6
CP-N
Canadian Pacific Kansas City Ltd
-0.33%88.17
CP-T
Canadian Pacific Kansas City Ltd
-0.37%119.63
GE-N
General Electric Company
-2.63%175.38
GM-N
General Motors Company
+1.64%45.32
GS-N
Goldman Sachs Group
+0.29%416.44
INTC-Q
Intel Corp
+1.46%44.41
JNJ-N
Johnson & Johnson
+0.43%158.64
MAT-Q
Mattel Inc
-0.1%19.74
MSFT-Q
Microsoft Corp
-0.09%421.03
NFLX-Q
Netflix Inc
-1.12%606.67
RCI-N
Rogers Communication
-0.19%41.12
SBUX-Q
Starbucks Corp
-0.03%91.47
V-N
Visa Inc
-0.4%277.91

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